Stein’s Law and New Zealand Wine

Stein’s Law, named for presidential economic advisor Herb Stein who coined it, holds that if something cannot go on forever it will eventually end.

If that sounds like an obvious conclusion remember that, Freakonomics aside, most of what economists do is point out the obvious to people who somehow fail to see it.

Think about everyone who was surprised that the housing bubble imploded and that credit crashed. Everyone knew that rising housing prices and expanding mortgage debt couldn’t go on forever, but many acted like it would never end. If only they had remembered Stein’s Law!

I wonder if this is a Stein’s Law moment for the New Zealand wine industry?

Objectively the New Zealand wine industry has all of the classic characteristics of a bubble (and I’m not talking about sparkling wine here). The industry has expanded at a break-neck pace in recent years, fueled by foreign investment. The home market is quite small, so increasing output has been pushed into export markets, especially Australia, the U.S. and Great Britain. New Zealand wines are best sellers in each of these markets.

Incredibly, New Zealand has been able to continually expand export sales while maintaining its historically high export price. (No country has received a higher average price for its table wine exports in recent years.) The high prices, of course, draw in more investment, so production continues to grow and the cycle repeats.

Chateau Ponzi

If I told you a story like this about a financial investment of some sort you’d probably tell me that it sounds like a Ponzi scheme — no way this can go on forever. Pretty soon the market will be saturated and prices will have to fall. This is what worried the New Zealand winemakers I talked with when I visited there a few years ago: the moment when exports at a premium price would become unsustainable. They worried that their fine wines would become commodities, sold in bulk at permanently lower price points.

Any luxury good retailer will tell you that it is hard to push prices back up once buyers come to expect discounts.

Yesterday’sMarlborough Express suggests that the tipping point may have been reached. The article reports that

New Zealand Winegrowers’ annual report released yesterday shows exports surged 24 per cent to $992 million and the industry is on track to reach the $1 billion mark this year, a year ahead of expectations.

This was largely driven by bulk exports, which Mr Smith said were a concern to the industry. Historically, bulk wine exports have accounted for less than 5 per cent of total export volume; in the past year this quadrupled to nearly 20 per cent as producers looked to shift excess inventories.

Bulk exports might relieve pressure on wineries in the short term, but in the long term they could damage the market positioning and the reputation of New Zealand wine, Mr Smith warned.

The fact of falling prices due to bulk sales is hard to dispute. I have not seen big discounts on New Zealand wine here in the U.S., but the Marlborough Express reports that

A surplus of Marlborough sauvignon blanc is driving down wine prices, says a Nelson wine producer. Brightwater Vineyards’ owner, Gary Neale, says his company is up against an oversupply of discounted Marlborough sauvignon blanc exports.

Mr Neale sells his wine for 10.50 (NZ$25.80) in Britain, but British consumers are being offered three bottles of Marlborough sauvignon blanc for 10 , or 3.99 for one bottle. An email from his Sydney agent tells of New Zealand wine being sold at A$4 a bottle, and Marlborough sauvignon blanc is selling there for as little as A$2.75 when buying six bottles.

“In the past, Australia has been a very easy and a profitable market, but Australia is absolutely flooded with cheap Marlborough sauvignon blanc,” says Mr Neale.

Two Buck Kiwi Wine

With the Australian dollar trading at about 83 U.S. cents this morning, that makes makes the Marlborough six-pack price a little over $2.25 US per bottle — Two Buck Chuck (TBC) range.

An article posted today on Decanter.com reports low prices in the U.K. market, too, although not so low as in Australia, and sounds an optimistic note.

The sale of £3.99 Marlborough Sauvignon Blanc is a short-term ‘blip’, according to the European head of New Zealand Winegrowers.

Following the record 2008 and 2009 vintages, increased production created an oversupply problem, giving rise to the first-ever £3.99 New Zealand wines as producers tried to clear tank space.

But David Cox, European director for New Zealand Winegrowers told decanter.com: ‘We are going to see the odd £3.99 New Zealand wine but not very often. I don’t think the consumer will ever get to the stage where they think they can get New Zealand wines for under £4.’

£3.99 translates to about $6.50 US — well clear of the TBC price, but frighteningly low for New Zealand wines in the UK market. Let’s put this price in context.

New Zealand producers received an average price of $6.00 for their exports in 2001-2005. Retail prices in the export markets were necessarily much higher to reflect transportation and distribution costs, tariffs and retail mark-ups. No wonder so many Marlborough Sauvignon Blancs have been priced in the $15-$20 range in the past.

If NZ wines are retailing for the equivalent of $6.50 in London then, working backwards, this suggests that net producer prices have plunged to less than $3, at least for the bulk wine product. That’s a huge drop and it is hard to see how production is sustainable at this price point.

All Black?

So is this it? Has the bubble burst? Is the future of New Zealand wine all black? No. The reputation of New Zealand wine is very strong and it may well be that consumers will be able to differentiate the bulk product at bulk price from the premium product higher up on the shelf as they do for products from France and California. The danger is that the whole national brand is devalued. That would be a devastating blow.

It would be a mistake to over-react to this news, but it would also be a mistake not to react at all.

Stein’s Law holds here as it does in so many cases and the surpluses will go away one way or another — either because the growers act to control them or else because the market collapses and they get sold off at bulk wine prices.

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Here’s a excerpt from a recent piece in the Doominion Post that suggests how Stein’s Law is starting to play out:

Grapes could give way to kiwifruit and avocados in Gisborne as grape growers reel from cutbacks by Pernod Ricard, the country’s biggest wine company.

Gisborne Grape Growers Society president John Clarke expects that the coming harvest in his region will drop by a fifth as Pernod Ricard cancels or buys out contracts with growers.

“The generally accepted figure seems to be a cut of 5000 tonnes 20 per cent of the Gisborne crop.”

Growers who lost their contracts with Pernod Ricard would have great difficulty finding other buyers for their grapes, he said. Chardonnay and pinot noir were the varieties most affected, as consumer demand has switched to sauvignon blanc.

Mr Clarke did not expect things to improve in the short term for Gisborne, the country’s third-biggest wine region, producing about 8 per cent of the 2009 harvest.

“Some growers will change to other varieties [of grapes] and some will switch to cropping, such as kiwifruit, avocados, citrus or apples,” he said.

Grower Tom Brodie said he was now selling a 20-hectare vineyard because it was no longer economic to grow grapes there.

“To buy the contract out they are offering $150 a tonne, with the tonnage based on the last three vintages,” he said. Normally he received up to $1800 a tonne.